AICPA SEC and PCAOB Conference Highlights
Representatives from Accounting Research Manager are attending the annual “AICPA Conference on Current SEC and PCAOB Developments.” This conference is being held Monday-Wednesday, December 10-12, 2018, in Washington, D.C. The following are some highlights from conference speeches or presentations.
SEC Chairman Jay Clayton and SEC Chief Accountant Wesley Bricker
Jay Clayton and Wesley Bricker held a joint discussion that emphasized the important role accountants and auditors play in protecting investors by their work and investor confidence in the profession. Chairman Clayton noted that audit quality is the bedrock of our capital system and we would not see the same level of capital formation we do today without the confidence placed on audited financial statements. SEC Chief Accountant Bricker indicated that audited financial statements “enable investors to make more informed decisions. Given their importance, the collective goal of all participants in the financial reporting architecture must be for the financial information to be complete and accurate and the audit report to be reliable, the first time the information is provided to investors. When it is not complete or accurate, at best, investors are left seeking potentially imperfect remedies for the defects. Therefore, preventing defects should be our collective first priority, while detecting and remedying them should be our second.”
|Clayton and Bricker highlighted important stakeholders in the Office of the Chief Accountant’s (OCA’s) Financial Reporting Structure Blue Print, which is a visual illustration of the players involved in the financial reporting process and includes various charts. These charts illustrate over 50 groups involved in the preparation, audit, delivery, and use of domestic and international public company reporting in the U.S. This visual illustration is available at on the SEC’s website at: https://www.sec.gov/financial-reporting-structure.|
Chairman Clayton was pleased with the appointment of 5 new members of the PCAOB who are all expected to be in attendance at the 2018 conference over the next few days. The transition to the new board has been going well, with Clayton and Bricker optimistic with the opportunity for significant coordination among the SEC, FASB, and PCAOB in the future on accounting and audit issues.
Clayton and Bricker were asked about the use of non-GAAP measures or Key Performance Issues (KPIs) provided by public companies. Companies providing non-GAAP measures or KPIs should do so with the same quality and accuracy as the GAAP numbers. Investors should be able to determine how these non-GAAP amounts are calculated and how they relate to the GAAP amounts provided in financial statements. Non-GAAP measures should be presented consistently, and if mistakes were made in previously reported non-GAAP items or KPIs, disclosure should be made regarding this and explained. If used, non-GAAP measures and KPIs should provide investors with insight on how management measures performance of the company beyond the information GAAP provides. Audit committees should continue to play a role in the use of non-GAAP measures and ensure controls are in place around their use.
Chairman Clayton indicated that financial reporting must evolve as our economy evolves. One example of disclosure that has been varied is around Brexit. Chairman Clayton indicated that he has seen a wide variety of disclosure levels regarding Brexit. In many ways the economic impact of Brexit has been misunderstood, underestimated, or a combination of both. Clayton urged companies to look at Brexit and to carefully consider disclosures regarding its impact on specific company operations and trends.
OCA has previously spoken about the importance of identifying and communicating material weaknesses before they manifest in the form of a financial statement restatement. Bricker indicated that they have seen progress made in the evaluation of the severity of internal control deficiencies. However, OCA encourages ongoing attention, including audit committee participation and training as needed, regarding the adequacy of and basis for a company’s effectiveness assessment, particularly where there are close calls in the assessment of whether a deficiency is a significant deficiency (and reported to the audit committee) or a material weakness (and reported also to investors).
Companies and directors should carefully choose who serves on their audit committees, selecting those who have the time, commitment, and experience to do the job well. Just possessing financial literacy may not be enough to understand the financial reporting requirements fully or to challenge senior management on major, complex decisions. Audit committees must stay abreast of these issues through adequate, tailored, and ongoing education. The audit committee also must be committed to its oversight of financial reporting, including through a properly balanced agenda toward understanding the accounting, internal control over financial reporting (ICFR), and reporting requirements.
Bricker indicated that the SEC will continue to encourage the FASB and the IASB to work together to keep converged standards converged, to reduce differences in standards where they continue to exist, and to continually look for opportunities to improve standards in producing decision-useful information for investors. Bricker indicated that although “U.S. GAAP continues to serve well the interests of investors and other stakeholders and will for the foreseeable future, it does not diminish the need – in the United States and abroad – to continue strongly supporting high quality international standards. We all, particularly U.S. investors and companies, have a very strong interest in such standards, including IFRS.”
Bricker announced at the conference that Jeff Minton, who has served as OCA’s Chief Counsel, is retiring from the agency. Giles Cohen, Deputy Chief Counsel, will serve as OCA’s acting Chief Counsel upon Jeff’s retirement.
Office of the Chief Accountant Current Projects
The Deputy Staff Accountants in the SEC’s OCA discussed several areas, including revenue recognition standard implementation and the new auditor’s report.
Revenue Recognition Implementation
The OCA indicated that the “implementation of the new revenue recognition standard was a substantial, yet manageable, effort involving extensive collaboration among preparers, auditors, investors, standard-setters, industry groups, and others with the shared goal of advancing high-quality financial reporting in our capital markets.”
The OCA staff indicated that questions regarding performance obligations continue to be the top consultation related to implementation of the standard. On example cited by OCA was the sale of software that allows the customer to prepare patent applications, and includes a free, one-time service of electronically submitting an application with the appropriate government agency, but the software also allows the customer to print out patent applications to submit by mail. The company concluded that the software and the service were capable of being distinct but were not distinct in the context of the contract since the registrant believed the promises were highly interdependent or highly interrelated based on the combined utility of the promises in the contract. However, OCA determined that the service was a convenience to the customer, but it was not required. In addition, the choice of whether or not to use the service did not significantly impact the utility of the software, and thus the identified promises did not significantly affect each other, and therefore were not highly interdependent or highly interrelated. As a result, OCA objected to the registrant’s conclusion that the promises in the contract comprised a single performance obligation.
The OCA will continue to monitor implementation of the revenue standard in 2019.
Companies are planning for adoption of the new leases standard, which will be effective soon. The guidance affects both lessees and lessors and the OCA continues to monitor its adoption. While nearly all companies will be affected, the magnitude of the impact on any one company will depend on the nature and extent of its leasing activities
OCA indicated that it believes companies are well on the way to executing their implementation plans. Given the approaching effective date, OCA indicated that it is critical for companies to continue to focus their implementation efforts to allow investors to benefit from the improved transparency and consistency intended by the FASB in the accounting and disclosure of lease arrangements. It is also critical for companies to identify and resolve transition, application, and other implementation issues arising from the new leases standard.
Current Expected Credit Losses
The new credit losses standard will be effective for many companies beginning in 2020. The standard generally applies to financial assets and net investments in leases that are not accounted for at fair value through earnings. OCA urged companies to actively monitor the implementation of the new standard, including the resolution of questions through the FASB’s Transition Resource Group.
The OCA noted that it has received consultation submissions regarding CECL, from which they continue to provide observations. More generally, the nature of consultations received has shifted from scoping questions to more specific application questions. Companies must not let their implementation planning or disclosure of the anticipated effects of the new standard lag during 2019 as the FASB continues to consider and respond to implementation questions.
The OCA staff indicated that SAB 102 is being updated for the new credit losses standard.
Transition Away from LIBOR
The FASB has recently issued an accounting standard which would allow for the Overnight Index Swap (OIS) rate based on the Secured Overnight Financing Rate (SOFR) to be designated as a benchmark interest rate. In addition, the FASB has added a project to its agenda to consider changes to GAAP necessitated by the anticipated transition away from LIBOR.OCA is supportive of these efforts and will continue to monitor the accounting issues.
OCA discussed a recent consultation regarding the transition away from LIBOR. The stakeholder noted that there are existing cash flow hedge relationships of variable rate debt instruments where the hedged item is documented as LIBOR based interest payments. The stakeholder requested the staff’s view on whether registrants could continue to assert that cash flow hedges where the hedged item is documented as LIBOR based interest payments are probable of occurring for variable rate debt whose terms extend beyond the anticipated transition away from LIBOR. The stakeholder shared its view that hedge documentation involving LIBOR based cash flows implicitly considers the rate that would replace LIBOR, thereby allowing an entity to continue to assert that the hedged item is probable of occurring. The staff did not object to this view.
The second question was whether and how the expected transition away from LIBOR would impact the assessment of hedge effectiveness of a cash flow hedge of LIBOR based variable rate debt. In order to apply hedge accounting, a hedge must be assessed as highly effective both on a prospective and retrospective basis. The stakeholder shared its view that, as part of its assessment of hedge effectiveness, an entity could consider an expectation that anticipated changes to LIBOR will impact both the hedged item (e.g., forecasted interest payments on debt) as well as the hedging instrument (e.g., interest rate swap). The stakeholder further asserted that in light of this expectation, the anticipated transition away from LIBOR in and of itself would not impact the effectiveness of the hedge. The staff did not object to this view.
New Auditor’s Report: Critical Audit Matters
OCA is focused on the implementation activities for the PCAOB’s new requirement for auditors to discuss critical audit matters (CAMs), beginning in 2019. OCA encourages auditors and registrants to:
- Conduct (or participate in) a dry run this year especially for those engagements that will be adopting the critical audit matter requirements in 2019 – practice builds confidence and improves results.
- Share implementation questions and other observations with the PCAOB staff and OCA.
- Understand similarities and differences in different disclosure requirements and standards.
A material weakness is a control deficiency, or a combination of control deficiencies, such that there is a reasonable possibility that a material misstatement of the financial statements will not be prevented or detected on a timely basis. The critical determination when evaluating the severity of a control deficiency is whether or not that deficiency, either alone or in combination with other identified control deficiencies, rises to the level of a material weakness. OCA cautioned that when making this determination, management should evaluate the level of detail and assurance needed to support their conclusions by considering what the views of a “prudent official” would be in conducting their own affairs. Specifically, management should consider the level of detail and degree of assurance that would satisfy a prudent official looking to obtain reasonable assurance that the financial statements are in conformity with GAAP.
OCA cautioned that the tendency to focus solely on the actual misstatements that occurred due to a deficiency was the topic of a speech at this very conference four years ago. From what OCA has observed since then, “there have been fewer instances in which the focus was just on actual misstatements when evaluating control deficiencies. With that said, some of our other recent experience indicates that there is still more work to be done.”
Material Weakness Disclosures
Management is required to conclude and state in its report whether ICFR is effective or ineffective. This report and the related material weakness disclosures, when ICFR has been deemed ineffective, should provide investors with meaningful information. OCA indicated that while it has observed improvements in the disclosures of material weaknesses by companies, “more could be done to make these disclosures more informative to investors.”
When disclosing a material weakness, OCA suggests considering the following questions to help determine if the disclosure would provide investors with the most meaningful information:
- Does the disclosure allow an investor to understand what went wrong in the control that resulted in a material weakness?
- Is it sufficiently clear from the disclosure what the impact of each material weakness is on the company’s financial statements? For example, is the material weakness pervasive or isolated to specific accounts or disclosures?
- Are management’s plans to remediate the material weakness sufficiently clear? For example, does disclosure of the remediation plans provide sufficient detail that an investor would understand what management’s plans are and how the remediation plans would address the identified material weakness?
Cynthia Fornelli, Executive Director for the Center for Audit Quality (CAQ)
Cynthia Fornelli discussed the overall state of investor confidence in U.S. capital markets and public company auditors. Fornelli shared results from the CAQ’s 12th Annual Main Street Investor Survey (Survey), which showed that “81% of US Main Street investors express confidence that independent auditors are effective in their investor protection role.” Fornelli urged conference participants to embrace a collaborative approach to enhancing the audit profession, indicating that “working together we gain strength and confidence.”
Fornelli also highlighted CAQ recent, or soon to be issued, publications that provide guidance on the new auditor’s report and the work of audit committees, including:
- Critical Audit Matters: Lessons Learned, Questions to Consider, and an Illustrative Example;
- Critical Audit Matters: Key Concepts and FAQs for Audit Committees, Investors, and Other Users of Financial Statements;
- The Auditor’s Report: Considerations for Audit Committees; and
- Audit Committee Transparency Barometer.
Fornelli indicated that she will be retiring from the CAQ early in 2019.
Barry Melancon, President and CEO of the American Institute of Certified Public Accountants (AICPA)
Barry Melancon welcomed conference attendees and urged them to be mindful of where our profession sits within an integrated global landscape. Melancon highlighted emerging areas facing the accounting and audit profession, including:
- Cybersecurity risk management;
- Integrated and sustainability reporting;
- Workforce changes;
- Regulatory complexity and international regulatory issues; and
- Emerging technologies.
The investing public has a significant need to have trust and confidence in the accounting and audit profession. Everyday each one of us in the profession must be committed to growing this trust and confidence in order to continue to play a crucial role in specific emerging trends facing our profession noted above. Even though U.S. GAAP remains separate from IFRS, Melancon believes that our profession should continue to have a voice in the development of international accounting standards in the future as an important stakeholder.
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